News

A Eurocentric cycle perspective

Sir, Samuel Brittan ("A semi-hard landing faces America", January 12, see below) is correct that the National Bureau of Economic Research defines a recession as a period of falling economic activity, but is entirely mistaken in his belief that activity means the "output gap".

In fact, Geoffrey H. Moore, who founded the Economic Cycle Research Institute and was long involved in determining business cycle dates at both the NBER and ECRI, defined recessions as periods of concerted contraction in output, employment, income and sales that were significant in terms of depth, duration and diffusion.

I suspect that Sir Samuel's confusion stems from a somewhat Eurocentric perspective. During the decades of rapid growth after the second world war, economic contractions became quite rare in Europe, inducing economists to define cyclical downturns in terms of deviations from trend, which could be related to the "output gap". In contrast, ECRI's international business cycle chronologies, which are comparable across countries, are based on the original definition of recession.

Those recession dates, available at www.businesscycle.com, show that during the past half-century, while the US experienced eight recessions, the UK saw only three recessions, Germany five and France six.

Since a recession entails economic contraction, it would be impossible for the NBER to declare a business cycle peak near the end of 2006 unless US economic growth is already negative.

A semi-hard landing faces America By Samuel BrittanPublished: January 12 2007, Financial Times

About the first question I was asked when I started writing about political economy was: "Is there going to be a US recession?" If one takes the popular definition of two successive quarters of falling gross domestic product, the answer is most likely not. The last time this occurred was 16 years ago in the winter of 1990-91.

A more sophisticated approach is provided by the National Bureau of Economic Research. Any period in which economic activity is rising is treated as an upturn and a period in which it is falling is treated as a recession. Activity seems to mean the pressure of demand on supply - nowadays sometimes called the "output gap". The bureau uses a variety of indicators to determine turning points and it will occasionally change its mind or defer a ruling. On its definitions recessions are short, averaging 10 months in the postwar period, while expansions average nearly five years. The last recession it recorded began in March 2001 and ended eight months later. It would not be surprising if it declared a cyclical peak near the end of 2006. But even NBER methodology has its limitations. It is indifferent, for instance, to the depth of any recession, or the extent, as distinct from duration, of any recovery.

What about the dollar? As Patrick Minford's Liverpool Investment Letter points out, US net foreign debt has hardly changed over the past two and a half decades, in spite of large payments deficits. This is a long way from the consensus view that the US needs a structural shift from growth based on consumer borrowing to growth focused on investment and net exports - a shift that has rarely been accomplished without an economic slowdown. The consensus among international forecasters favours a soft landing. This means a period of US growth falling from 3-4 per cent to, say, 2 per cent a year with some of the slack being taken up by an acceleration in Europe and Japan.

Many forecasters guard themselves by saying that the risks are on the downside. The domestic risk most frequently cited is the housing market. US consumer spending accounts for more than 20 per cent of world GDP; and a further housing shock could yet have an impact on the world economy. So far, however, the housing market has been the dog that failed to bark, not only in the US but in English-speaking countries such as the UK and Australia. Consumer spending in these countries has decelerated, but not ground to a halt.

More interesting is the fact noted by Andrew Balls of Pimco that the oil exporters have taken over from developing Asian nations as the largest components of the global savings glut. He also points out that the scare about China is overdone. For all its rapid growth, in nominal dollars China's economy is still not much larger than the UK's.

If oil-exporting countries continue to park their surpluses with the US it could postpone even further the long-predicted dollar crisis. If, on the other hand, they try to shift some of their reserves to the eurozone, the euro could appreciate further and damp the developing European recovery. No doubt the Europeans would be pressed by the US to follow a more expansionary policy, as they have been in almost every past year. They have been answered in advance by Jean-Claude Trichet, European Central Bank president, in the December ECB monthly bulletin which states: "Following several years of robust monetary growth, the liquidity situation in the euro area is ample by all plausible measures." This points to "upside risks to price stability over the medium to longer term". The assessment is about right and applies to the UK as well, as the Bank of England has recognised with yesterday's rate increase, probably decided by majority vote.

None of this means that Europe can escape a world slowdown. Anyone who doubts that inflation and recession can coincide has only to look at the "stagflation" of the 1970s or the experience of Latin America over centuries. Ben Bernanke, Federal Reserve chairman, will be reluctant to initiate interest rate cuts until he is confident inflationary expectations are under control and are not just being damped by a possibly short-lived shakeout in oil and commodity prices.

All these matters fade into insignificance compared with the repercussions of a strike by Israel against Iran, from which it would be difficult for the US to stand aside. Such an attack would have to be within the next two years while President George W. Bush is still at the White House. "This is improbable but not as remote a possibility as the market appears to think." These words do not come from a cantankerous academic or a journalist looking for a headline but appear in a study by the highly respectable international banking firm of ING.

At the end of the day, my own "most likely" forecast is a semi-hard landing - say, average US growth of 1 per cent in 2007-08 - which may not amount to a recession under the popular definition but would still be pretty nasty.